Zombies R U.S.
Morgan Reynolds* — December 5, 2008
You think it’s bad now? It’s going to get much worse. This is the big one, call it Great Depression II. Why am I so sure? Because the depth and duration of a downturn depend positively on 1) how long the preceding boom lasted, 2) how distorted its capital structure became, and most importantly, 3) how much government interferes with the classical medicine administered by the marketplace.
By these metrics, our current economy is one sick puppy and getting sicker. But what caused this? Ironically, economic problems usually result from a prior intervention too hard for most to trace and so lead to demands for new interventions to “fix” the problems. Nowhere is this confusion truer than for the mystery of the business cycle.
The cause of our sick economy was world-class injections of artificial credit by Maestro Greenspan and his Merry Band for double-digit years. Now the inevitable bust is being aggravated by “stimulus” programs mercilessly foisted on us by Ben Bernanke, in turn aided and abetted by big business pleaders, business media, Paulson, Congress, state governments, Ohio school districts, and assorted panhandlers in business suits.
Arrogant economists bear a heavy burden for this madness because, preoccupied by their mathematical models, they have failed to heed the Austrian Business Cycle Theory (ABCT). Only ABCT explains the wave-like, boom-bust pattern of the business economy.
The determined ignorance of most economists reminds me of a cartoon which showed two men watching a Soviet May Day parade bristling with missiles, tanks and soldiers, and one asked, “Who are those guys marching in their business suits?” “Oh, those are economists,” his friend replied. “You’d be surprised at how much damage they can do.”
ABCT is scientifically successful because in a field of macroeconomic-model failures, it is the only theory of business fluctuations based on individual behavior. Even the greatest economists of all time like Irving Fisher and Milton Friedman never “got it” because although they focused on individuals and prices in their microeconomic or price theory, they largely dispensed with these in their macroeconomic or money theory. This “separation theorem” has produced immense, avoidable suffering.
Virtually all economists acknowledge that prices have heavy lifting to do, at least when it comes to micro matters. Prices transmit information, provide incentives to consumers and producers to follow this information, and coordinate or harmonize the actions of buyers and sellers in the marketplace. And what if crucial prices are false? Put aside temporarily deranged market prices—they will be corrected—but consider prices deliberately distorted for extended periods of time. That causes big trouble. Where would such lies come from? One guess: government intervention.
What prices do I have in mind? Interest rates of course. Interest rates in a free market are determined by time preferences: if, say, households voluntarily increase their savings, they give up some present consumption spending in favor of the opportunity for increased future consumption. These actions increase the supply of loanable funds which, in turn, lowers the interest rate. Since the interest rate regulates the temporal order of choice of investments in accordance with urgency, a lower rate signals that more projects, especially projects with more distant payoffs, can be profitably undertaken. This constitutes healthy coordination among savers, investors, and entrepreneurs and induces a production structure in accord with consumer demand.
Now “wise” central planners (the Fed) get into the act. Its cheap credit policies induce entrepreneurs to undertake previously unprofitable projects, especially capital intensive, lengthier projects, say, lots of new houses. The new credit is not backed by voluntary savings and there is no downward shift in time preference. Credit expansion does not bump up total investment because it still must come from unchanged or even smaller savings, which equal investment after the fact; meanwhile, the cheap rate misdirects investment into wrong projects that cannot pay off. Businesses overinvest in the higher stages of production, as Austrian-style economists say, and underinvest in the lower stages.
The market ultimately reacts to the Fed’s distortion of the free-market interest rate by reverting to a higher market rate: “This process—by which the market reverts to its preferred interest rate and eliminates the distortion caused by credit expansion—is, moreover, the business cycle!,” Murray Rothbard wrote. He called it a “distortion-reversion” process.
Wall Street gradually caught on that all is not well on Main Street. Main Street failures preceded Wall Street’s, not vice versa. Depression is our next stage as malinvested businesses go bankrupt and land, labor and capital shift back to lower stages of production. Liquidation of unsound businesses, “idle capacity” of malinvested plants, and unemployed resources must shift to lower stages of production.
The deception orchestrated by the Fed suckered businesses into overinvesting in capital goods industries, contrary to consumers’ wishes. Sad, isn’t it? The massive wasted saving and investment squandered in bankrupt businesses is appalling, akin to the wastes of war.
Conventional business cycle theory cannot get much “wronger.” Maybe the worst part is that “depression expert” Bernanke is clueless, virtually guaranteeing a depression. As I wrote in March 2006:
“Bernanke’s paper trail tells us…he fears falling money prices as the biggest risk of all, so he stands ready with ‘an invention called the printing press’ to combat this evil. He promises faster inflation [er, ‘quantitative easing’] in response to the next financial crisis, supplying the ‘liquidity’ the system needs…Mr. Ph.D. does not understand why a bust happens. That makes him extra dangerous. Every bust is caused by the preceding boom and its excesses. The bust is curative…When Bernanke fights the market by injecting new credit in the next crisis he will sustain unsound debt, weak debtors and lousy companies, prolonging depression. That’s the opposite of ‘putting it behind us.’” Bernanke can fight the market but he cannot win. However, he might destroy the rest of us in the meantime.
*Morgan Reynolds is professor of economics emeritus, Texas A&M University. He was chief economist at the U.S. Department of Labor, 2001-2. His website is nomoregames.net.